Markets

Relatively speaking

Distinguishing between price and purchasing power.

I wanted to share an update about how I’ve been using M2 Money Supply to normalize and make sense of rising asset prices. We’re in the midst of a particularly unintuitive environment. Normalizing values against the rising money supply tide has been a helpful tool for seeing through the distortions it’s creating.


Exponential Money Supply Expansion

As I discussed in The Cantillon Effect, the broad money supply of US Dollars (M2) is expanding at an increasingly exponential rate. And is poised to continue for the foreseeable future with ~$5T of stimulus planned for 2021. Here’s the most current chart:

M2 Money Supply, Monthly
M2 Money Supply, Monthly

In the face of meaningful monetary debasement, prices rise while purchasing power of each dollar unit falls. It’s counterintuitive because all we’ve ever been trained to know is that more money equals more purchasing power.

Yet, relatively speaking, this is only true if your rate of growth is more than the debasement rate.

This is much easier to achieve when the money supply is stable or growing slowly. Right now, neither is the case.

As a result, prices and purchasing power are decoupling from one another and many assets are experiencing what I’ve been calling “hidden” devaluations:

A situation where prices are rising, but not enough to keep pace with the debasement rate of the dollar resulting in a net reduction in purchasing power over time.

It’s difficult to appreciate the impact of the parabolic curvature of money supply day-to-day. But there is an increasingly-unmistakeable force in our midst that is warping and distorting our perception of reality and masking what’s happening underneath the surface.


Hurdle (or more accurately, High Jump) Rate

At this moment the annual breakeven hurdle rate for investments is 25%:

In 2020 the US Dollar supply increased ~25%. This reduced the purchasing power of every US Dollar by ~20% (100/100 = 100%, 100/125 = 80%).

This 20% reduction in purchasing power means that starting 2020 with $100 is the same as starting 2021 with $125. Meaning a 25% annual increase in dollar unit holdings is required to maintain purchasing power.

This is a drastic departure from the ~2% annual inflation/debasement rate we experienced from the 1970’s until the GFE in 2008.

It might be more accurate to call it a “high jump” rate at this point 😉


Dollar Index (DXY)

If the drastic debasement of the US Dollar against itself wasn’t enough, the weakening is being compounded with the reality that the US has been debasing its currency at greater rate than other major currencies. This relative weakening is illustrated by the Dollar Index chart (down 11.7% since March 2020):

US Dollar Index (DXY), Weekly
US Dollar Index (DXY), Weekly

We’re experiencing exponential price growth in so many pockets of the economy because of two compounding factors: the dollar weakening against itself while at the same time also weakening against other global currencies.

Prices of assets are up bigly mostly because the US Dollar value measuring stick we’re using as a compass is collapsing. Not necessarily because value/purchasing power is increasing.


S&P 500

Despite prices setting new all time highs, the S&P was only up ~12% in 2020. Meaning the S&P was down 11.4% in purchasing power last year (112/125 = 89.6%).

In fact, the S&P has yet to regain it’s Feb 2020 highs in M2-adjusted terms and has never come remotely close to it’s 2000 all time high:

SPX/M2, Monthly
SPX/M2, Monthly

Real Estate

I recently shared an M2-adjusted analysis of Sacramento median home prices on Twitter.

It shows that, despite prices setting new all time highs fueled by historically low interest rates, Sacramento real estate has been in a “hidden” devaluation since May 2018:


Plan ₿ (Bitcoin)

Bitcoin is one of the few asset classes that is setting new all time highs in both price and M2-adjusted terms:

BTC/M2, Monthly, Log Scale
BTC/M2, Monthly, Log Scale

Another interesting observation:

Though Bitcoin broke above the previous 2017 all time high price of $20k in December 2020, the run up to $42k and retracement to $28k in January 2021 was actually the breakout and retest of BTC/M2 all time highs.

It’s a great example of how nominal prices can feel overextended, while the reality in purchasing power terms is less so:

BTC (Left) vs. BTC/M2 (Right), Weekly
BTC (Left) vs. BTC/M2 (Right), Weekly

Lastly, I thought it’d be interesting to compare the post-halving 2013 and 2017 BTC/M2 bull cycle fractals to the current cycle.

Given how disorienting and unintuitive the current dynamics are, it provides a decent sketch of what’s possible based on previous cycles:

BTC/M2, Weekly, Log Scale
BTC/M2, Weekly, Log Scale

Averaging the two past cycles points to a cycle top ~$500k August 2021.

I don’t make investment decisions based on fractals, but the exercise illustrates (1) the price convexity that can occur when the value of an asset is increasing in real terms while the underlying currency is collapsing, and (2) how prices can extend beyond our previous expectations of what’s possible when that happens.


The moral of the story?

Be careful what you tell yourself is possible. You might just realize it.

  • Price alone isn’t a reliable measure of success.
  • We’re in an environment where prices of devalued assets still go up.
  • If prices of assets experiencing “hidden” devaluations are rising aggressively, prices of assets rising in M2-adjusted terms will rise an unintuitive amount.
  • The real gains will be found in assets like Bitcoin that are (1) rising in purchasing power terms, and (2) early in the mass-adoption cycle (For reference, Bitcoin is currently ~2% global adoption).
  • We’re in uncharted waters. Focus on purchasing power and keep an open mind about prices.

🤝 Stay in touch

I send an email several times a year with a handful of the most interesting things I’ve written or uncovered at home, abroad, and on the web.

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